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गृहपृष्ठ The Fallacy of Intermediary Economy and Profit Fixation

The Fallacy of Intermediary Economy and Profit Fixation

A daily newspaper recently published Nepal government’s impression and solution regarding intermediaries. The Department of Commerce, Supplies and Consumer Protection’s (DoCSCP) study considers multiple intermediaries as a source of elevated price. The same news informs that the government is foreseeing two ways to address this problem. The first way is to minimize the intermediaries and second is to fix the profit range for relevant enterprises. Both of these approaches are misleading and yield negative effects on the distribution and overall economy.

Every product has its demand elasticity. It is the change in quantity demanded due to change in its price. A high demand elasticity means that a small change in price will highly change the quantity demanded. Chocolate candy is an example. A small change in candy price will motivate users to select alternative candies which will decrease the demand of specific candy. However, some products and services have less demand elasticity. One of the important examples is insulin. It is a life-saving drug so change in price will not impact quantity demanded.

This demand elasticity directly affects the revenue of any enterprise. For any highly elastic product, the increase in price will not increase their revenue. Because, there are alternative products in the market. The customer will select another product which is cheaper.

Similar argument holds true in the case of the DoCSCP’s decision to eliminate intermediaries. Limiting layers of intermediaries will minimize the probability of selecting a particular intermediary. This limitation in option will make the service inelastic. There will be fewer alternatives to choose although change in price occurs. It will enable monopoly pricing in the supply system due to limited actors in the hierarchy.

Limiting layers of intermediaries will minimize the probability of selecting a particular intermediary.

For example, a small or a startup company will not engage in different hierarchies of supply as its initial market size and production volume will be small. It will directly discuss a wholesaler or a retailer to sell its products. Limiting intermediaries will restrict its decision to select from different alternative layers of intermediary as per its business status. Such limitation on selection develops a monopolistic pricing in the supply chain. There will not be change in service due to the change in price. The news puts, the department has proposed three layers of businesses in their primary draft. However, a planned intermediary layer will limit competition and monopolize the price system.

The next approach discussed in the paper put forward by DoCSCP is profit fixation. Firstly, it is not as easy as it seems. If the government allocates a fixed amount of profit in water then what will happen to its factors and sub-sectors? Will the wage of people working in this sector be fixed? Will the price of land where water is produced be fixed? Will energy utilization by these companies be fixed? Will the cost of transportation of water be fixed? It is not easy for any government to keep track and control each and every factor and sub-sectors affected by a particular sector. Furthermore, the limitation on pricing decisions will discourage enterprises and deter entrepreneurship in the economy.

Moreover, such fixation of profit contradicts autocorrection of demand and supply in the market. If the existing profit is higher than the fixed range, the entrepreneurs will tend to hide their actual profit. Concealing real profit will increase black economy and reduce the amount of tax revenue to the government.

In other situations, there will be shortage of supply in the market. The range of profit is fixed. Therefore, entrepreneurs will not produce more although there is high demand in the market. They will not be able to earn more due to fixed profit range. The high demand and quota supply will create shortage in the market. The shortage will further allow the sale of products at high price through the black market. During the planned economy, China faced a general shortage of almost everything in the city due to inadequate production.

If the government believes there are problems in existing distribution it shall develop a competitive environment in the supply-chain. The government can motivate more participants through tax incentives. For highly inelastic products like specific medicine, the government itself can participate in the supply chain as a service provider through public companies.

However, the competition shall exist in both vertical and horizontal form. A vertical competition creates different layers from the production to distribution. Any customer shall be able to select appropriate layers as per their business status. A startup might directly go to the market whereas a multinational company may hire an experienced distributor. A horizontal competition will enable competition at each layer of the supply system.

The government shall develop an environment where economic agents are free to choose. The choice shall extend from production, supply to consumption. Interventions in the form of price and quantity fixation will harm general consumers through shortage, monopoly pricing and black market. It will only benefit limited existing agents of the supply chain. Furthermore, this kind of unnecessary intervention and framework will discourage participation and induce additional cost of taxpayer money in the form of monitoring and regulation.

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